Mark Lister: Getting a head start on the sharemarket

New Zealand's sharemarket fell 40 per cent during the global financial crisis in 2008.

The first issue for someone considering investing in shares is to understand where shares fit into the investment landscape. There are really only four "proper" investments: fixed income, commodities, property and businesses.

Fixed income is cash, term deposits and bonds, while commodities include things such as gold, timber, silver and so on.

Property is obvious and covers all the various sectors, including residential and commercial, while businesses span the full spectrum of companies, from a local hair salon to a McDonald's franchise, and stakes in companies listed on the stock market, widely referred to as shares.

The terms stocks, shares and equities are interchangeable, all describing listed companies.

Shares are businesses. When you buy a share, you are buying a slice of ownership of a business, nothing more or less. Shares are riskier than property, which makes sense when you consider that businesses face more risks and uncertainties than does the property sector.

Why not just keep the money in the bank? Because of inflation. Even with inflation at just 3 per cent your cash will lose 15 per cent of its spending power in just five years.

Real assets, like shares and property, that can increase their income in line with inflation, are an important protection against inflation.

But shares have a downside, literally. Share prices can be volatile. Our market fell 40 per cent during the global financial crisis in 2008.

Thankfully, it has recovered 30 per cent since then but people who invested just before the 2007 market peak could still be down by 25 per cent.

This volatility clearly puts a lot of people off shares. There are ways of reducing this volatility, by holding a diversified share portfolio, including overseas ones, and by biasing a portfolio towards more defensive companies with reasonable dividend yields.

There is a huge debate about which is best - property or shares. This question misses the point. Both are good investments and it is better to own both in a diversified portfolio than choose one over the other.

Have a diversified portfolio of shares. There is no perfect number of shares for a portfolio, but more is generally better than less. Hold companies from a range of sectors and markets.

When you invest in shares, regard it as an investment in people. While companies often own valuable assets, the management and board of directors will have a big influence on the performance of the company.

The board of directors job is to protect the interests of shareholders. They hire, manage and pay the chief executive and also ratify key strategic decisions. Directors are elected by shareholders.

Companies usually have two main communications a year with shareholders, when they announce their interim and full-year financial results.

A company with a June 30 year-end will announce its interim result for the half year to December in February. The interim dividend is usually paid in March. The final result will be announced in August followed by the payment of the final dividend in September and the AGM (annual general meeting) in October.

If you are new to shares, it can be important to start slowly. There are two reasons for this. Investing all of the capital you have earmarked for shares on one day means you run the risk of investing just before a market fall.

Spreading your buying over a period of time, even a couple of years, is a safer way to invest.

Also, investing gradually lets you get accustomed to owning shares without having too much money invested from day one. They do take some getting used to. Owning shares is not like owning a property. The price of your property isn't in the newspaper every night or flickering on the internet during the day.

Understand your share investments. One of the reasons people like shares is the intellectual aspect. Following companies, monitoring the economy, following management teams and directors you admire can be an interesting pursuit.

Investing in shares suits people who like reading and learning, and who like debating the merits or otherwise of various shares with their broker.

The Shareholders Association is best known for its work on corporate governance and speaking out in support of small shareholder interests. But it also does sterling work in providing education and a discussion group for people new to investing in shares.

In general terms, for the core of a portfolio, a good place to start is to look for quality companies that are trading at reasonable prices.

Solid companies tend to be larger, are well run, have a strong balance sheet, a sustainable competitive advantage and have the potential to grow earnings in future.

Value is an important element of the investment decision. Even the best companies can be bad investments if you pay too much for them. A reasonable price doesn't mean a low price.

Value is measured in terms of the share price relative to the company's earnings and dividends. A company with a share price of $7.50 can be cheaper than one with a share price of 7.5c.

Analysts most commonly use a discounted cash flow (DCF) model to value shares. But the tried and true price-earnings (PE) ratio and dividend yield are still very good measures of value.

A PE ratio is calculated by dividing a company's share price by its net profit per share. Listed companies usually trade on 12 to 15 times earnings (profits). Some trade on less, if they have a more subdued outlook, while high-quality companies will trade on higher PE ratios.

A share's dividend yield is the return from dividends. For example, a company with a share price of $1 that pays a dividend of 5 cents a share will have a dividend yield of 5 per cent.

Riskier companies can be good niche investments in a share portfolio as well. They can add some spice to a portfolio of blue chips.

But be disciplined. It can be helpful to write down a few rules for how you are going to invest in shares. Some people outline how many shares they want to own and what sort of companies they will look for.

They also set limits on how much they will invest in riskier companies, or detail how much they will invest outside New Zealand or in various sectors. A set of guidelines like this can be a helpful roadmap for your share investing.

Aim to hold for the long term, but be prepared to sell. Investing in shares is best regarded as a long-term endeavour, but there will be times when shares need to be sold. If they have disappointed, or have hit problems, then they may warrant removal from your portfolio.

Arguably the best thing about investing in shares are dividend cheques. Many people don't realise there are two forms of return from shares.

Capital gains from a rising share price is the most widely understood form of return, but the return from dividends is also important.

Over the long term, profits drive a share price. If a company can grow its profits and dividends, and it has a promising future, its share price should rise.

Investing in shares can be rewarding and interesting, and a focus on quality stocks, dividends, investing gradually and having a disciplined approach can be helpful strategies for investors new to shares.

* Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as specific investment advice.